In Russia, where bureaucratic markets have been legalized, power and influence is highly monopolized, even by socialist standards. Liberalization and privatization of prices and trade have led to a cutthroat battle for redistribution of and control over property, resources, and allocation channels, and also have fed economic crime.
Types of Wrongdoing
Economic crime is hardly a new phenomenon. As long as people have exchanged goods, they have cheated. With the rapid development of technology and communications and the explosive increase in financial interactions between people in the second part of the twentieth century, economic crime has become a highly diversified and fast-growing industry. It is impossible to point to crimes that are specific to countries currently in transition, but some particular crimes flourish in transition, some could not be committed during socialism, and others decline when reforms begin. Illegal economic activities can be grouped in the following broad categories:
• Corruption—abusing power related to a particular job or position to gain unlawfully wealth or influence.
• Fraud—financial gain obtained through loopholes in regulations, manipulation, or exploitation of public or personal trust (smuggling, illegal operations with hard currency, falsified bankruptcies, forgery, falsified credits, illegal capital flight, and so on).
• Theft and extortion (racket)—direct (physical) intervention of criminals; expropriation of property or the property rights of others.
• Tax evasion. This category is beyond the scope of the this aticle. (Russia’s tax police in the first half of 1996 uncovered about 12,000 cases of evasion resulting in 3,100 criminal cases, raising 13 trillion rubles for state coffers, and lodged penalties that will bring in another 9.3 trillion rubles, Interfax News Agency reported. Compared with previous years, the numbers reveal a change in government policies on tax evasion. During 1994 only 1,500 tax offenses were filed in court, of which only 20 cases were considered as criminal and only 10 saw sentences pronounced. In 1995, of 4,229 tax evasion cases, 1,611 were considered criminal and 312 evaders were sent to court.) There is a crucial difference between the second economy and economic crime. The second economy is a productive sector guilty of one main crime—tax evasion; economic crime is only a redistributor of wealth.
Crime Then and Now
In the Soviet Union theft of socialist property, corruption, and illegal hard currency operations were the major economic crimes. Large-scale theft of socialist property and massive fraud involving hard currency could be, and were, punished by death. (William A. Clark analyzed trials of Soviet government officials and enterprise managers charged with economic crimes, as reported by the Soviet press between 1965 and 1990. Of the 849 officials tried, about 500 received jail sentences, with an average of eleven years jail for embezzling public property and eight for bribery. Thirty-two persons were sentenced to be executed.)
In 1994, particularly, the Russian public discovered how much damage can be done by investment fraud and pyramids. Since the collapse of the Soviet Union new business rules, including the opportunity to establish limited liability companies, have opened a wide gate for fraud and other market type economic, white-collar crimes. Crime has become a highly profitable business in Russia. From an international perspective, the Russian criminal economy is extremely efficient. The sudden explosion of economic crimes has caught the Russian public and the government off guard. According to some estimates, the 1994 worldwide average per capita income from economic crime reached $100. The corresponding figure for Russia, however, was $130, assuming 38.4 trillion rubles in annual crime-related income (box 1). In Ukraine revenue from the infamous black economy reached $1.3 billion in 1994, or only $25.20 per capita.
A high degree of the criminality in the transition economies was brought about by the privatization and marketization processes. These crimes are not specific to transition economies but rather are related to the process of redistributing property rights. In Great Britain, for example, the Thatcherite promotion of popular capitalism during the 1980s distributed shares of denationalized industries to a large number of first-time investors. Despite the best intentions of policymakers and special legislation to protect investors (absent in Russia when privatization started), many small investors were tricked into selling their shares at unfairly low prices to those who flocked to London to take advantage of the new, deregulated financial markets.
Economic crime is mobile. It is moving away from traditional sectors, such as industry and agriculture, and from traditional activities, like property theft and improprieties in the office, to new sectors, such as banking and insurance, and new activities that require sophisticated skills and organizational structures. The number of economic crimes in industry and agriculture in Russia declined from 36 percent of total registered crimes in 1993 to 25 percent in 1994, while the number of crimes in the financial sector more than doubled during the same period (a tenfold increase between 1992 and 1994). The share of skilled crime (fraud, illegal hard currency operations and counterfeiting, falsification of securities) increased to 31.3 percent in 1994 from 16.9 percent in 1993, while the share of routine thefts in the economy went down to 9.8 percent from 15.6 percent during the same period.
Fertile Ground for Criminals
Bribery and corruption are unavoidable in the current situation because the salaries of public servants are several times below the level of available supplementary income. For example, the salary of a top-ranking police officer in Moscow is about $200 a month, while street patrols in the capital can demand $100 to look away if they spot drunk drivers. Experienced detectives leave the service. Junior and mid-level judges get about $160 month, less than half what a secretary receives in the burgeoning private sector. And the anticipated gain is always high enough to dwarf the expected punishment.
With property rights unclear and lacking well-established rules, government officials in charge of redistributing property and company insiders with the necessary connections can hardly resist the available opportunities to enrich themselves. Presumably, many privatizations were inappropriate if not downright fradulent. Although the real scale of misrepresentation probably will never be revealed because of the involvement of top officials. (For example, in late 1992, before Gazprom was privatized, the giant Russian natural gas monopoly was valued officially at $298 million; Western sources however, estimated its realmarket value as at least $250 billion.) Clearly, some in the leadership are interested in maintaining uncertainty and delaying the introduction of clear rules that could dramatically reduce their profits and rents from the redistribution of assets.
Because of the highly discretionary process of resource and benefits allocation by government staff, rent-seeking is rampant. Reports indicated, for example, that, with a 10 to 20 percent commission paid in cash criminal groups could persuade commercial banks to provide an advantageous credit line. Another example: Sports Foundation, a nongovernmental organization with government connections, was granted an export/import tax exemption that helped it keep $4.2 billion in profits. The price of such corrupt practices can be steep. The high murder rate of directors of oil refinery enterprises (second only to that of bankers) is explained by their access to almost unlimited rents and opportunities for theft—a result of the oil monopoly and the discrepancy between domestic and world market prices.
A comprehensive criminal code, incorporating measures against these kinds of economic offenses, still awaits final approval by the Duma (see Transition, November-December 1995, page 7). Meanwhile, new players are working and new financial transactions are being conducted without a clear regulatory framework. According to the chairman of Incombank, Vladimir Vinogradov, you have to have 10 or 15 people who can give a credit and about 1,000 who make sure the agreements are enforceable. As a result dishonest players have a lot of room to maneuver, and players (local and foreign) who want to play by the rules are often forced to make lubricating payments to get the deal done.
Laundering money in Russia is almost as easy as conducting a regular financial transaction.
• Privatization enables the transfer of large amounts of cash into assets, due to the lack of a legal and regulatory framework.
• Access to offshore transactions is more or less unregulated. As a result, about half of all foreign investment in Russia originates from illegal domestic transactions, proceeds of which were laundered through offshore banks, according to Russian financial experts. About 40 percent of Russian investment abroad is illegally exported capital, mostly held in cash, securities, and real estate, according to an EBRD report.
• The economy is cash-oriented. About 40 percent of the working capital used in the economy in 1993 was estimated to be in cash (an increase from 20 percent in 1992). Thus the government is unable to track most cash-related transactions.
Positive and Negative Scenarios
Until this first massive property redistribution is complete, crime associated with privatization and the misuse of enterprise funds can hardly abate. The same is true for crime connected to the redistribution of limited resources, such as credits, government aid, export and import licenses, and tax exemptions. But once market prices and market leverage prevail in distribution and competition strengthens, rent-seeking opportunities will decrease significantly. Transparency in decisionmaking and clarification of property rights will also help to drive crime out of business. The fight against fraud—especially pyramid schemes, which affect a large part of the population through lost savings—can be waged effectively by improving civil and commercial codes, inserting specific articles in the criminal code, and publicizing hearings and convictions of pyramid builders.
The rapid growth of financial fraud (box 2) parallels the speedy development of the banking and insurance sectors and lack of control over financial flows. (Moscow, Russia’s financial capital, records an annual 13.3 crimes committed in the financial sector per 100,000 Muscovites, almost twice the country’s average of 7.6 per 100,000 people.) One can assume that with the further refinement of banking institutions and strengthening of financial regulations, the number of crimes (though not necessarily the overall extent of losses) will go down. Growth of financial crimes in the banking sector is already slowing: these types of crimes jumped fourfold between 1992 and 1993 but only doubled between 1993 and 1994. The consolidation of the banking sector, which started in 1995, together with the tightening of central bank requirements and oversight of financial activities, are other encouraging trends.
And what are the prospects of the Russian economy if economic crime could not be checked? In a worst case scenario Russia could become a country run by keiretsu—powerful groups formed as symbiosis of criminal and official organizations with stakes in extracting and mining, manufacturing, international trade, with Moscow as their financial center.
Finance Is the Largest Crime-Income Generator
In 1994 total revenue from economic crime in 1994 amounted to at least 38.4 trillion rubles ($17.4 billion at the average annual dollar-ruble exchange rate) or 6.1 percent of GDP, which is almost as much as the 6.3 percent share of agriculture in GDP and more than the value added tax collected by the federal budget (6 percent of GDP in 1994).
Of the 38.4 trillion rubles in illegal revenues, yields from pyramids and other investment projects accounted for 20 trillion rubles. Adjusting for one-time fluctuations (the early 1990s were record years for criminals; many pyramid schemes have since collapsed ), in 1994 criminal revenues still amounted to 22.4 trillion rubles, or 3.6 percent of GDP. The financial sector generated 53 percent of all criminal income, (12 trillion rubles, or $5.4 billion). Two-thirds of this amount came from falsified credit and other payment operations and one- third from pyramid frauds.
Fraud Is Surging
Russian criminal statistics report misappropriation of property and property rights in a single category, regardless of whether the case was fraud, theft, or racket. About 50 percent of all recorded economic crimes are identified as property thefts. Theft from the workplace has become a low profit activity, and economic crime has become more of a white-collar business: fraud increased fortyfold between 1992 and 1995.
A breakdown of fraud by sector in 1994 (the latest year this data set has been available) indicates that most cases of fraud—24 percent—were committed in the financial sector, followed by commerce and catering (13 percent), industry (9 percent), and agriculture (7 percent). Two major cities, Moscow and St. Petersburg, accounted for 28 percent of all fraud cases.
Professional crimes have shot up in recent years. Their share in all registered crimes increased from 17 percent in 1993 to 34 percent in 1995. The share of crimes related to abusing position or office for private gain dropped notably—the incidense of office malfeasance and appropriation of entrusted property fell from 47.7 percent of all recorded economic crimes in 1993 to 35.6 percent in 1995. About one-third of all cases of office malfeasance were related to bribery. In 1994 government officials were involved in 25 percent of all recorded bribery cases. In 1995 law enforcement officers were implicated in 10.9 percent of all recorded cases of office malfeasance (7.6 percent were involved in 1994).